With so much talk about Central Bank Digital Currency (CBDC), it is not a coincidence that Agustín Carstens, General Manager, Bank for International Settlements chose this topic to give at the 9th Whitaker Lecture in Dublin at the end of March.
The key for Mr Carstens is not the ‘D’ in CBDC – we are all used to the digital world – but the ‘CB’ – or Central Bank – element. A CBDC would allow members of the public to make payments electronically with money issued by a central bank. They could deposit money direct into and use debit cards issued by a central bank.
The consequences of such a system are far reaching and would be very different to what we have now. Our monetary system is the backbone of our financial system, so it is worth understanding the consequences before embarking on radical change.
One half of our monetary system is money – and its three purposes have not changed much over time – a unit of account, means of exchange and a store of wealth. The other half of the monetary system is payment systems, which also come in many shapes and sizes. For example, retail systems typically handle large volumes of relatively low-value payments, whereas wholesale systems handle large-value and high-priority payments like interbank transfers.
Two worldwide trends have been driving change in payment system design for quite some time. One is speed, especially in the retail systems. The other is globalisation, which has increased demand for cross border payments and thus helped drive the development of the Eurosystem’s new Target Instant Payment Settlements services, TIPS, which can handle multiple currencies.
Both money and payment systems are essential to the functioning of a modern economy. Both rely on trust. We accept money as payment because we trust that we can pass it on to someone else later. Maintaining that trust in the monetary system is generally regarded as a number one priority in any economy and in most countries, it is the responsibility of the central bank.
The CBDC debate is not about the technology, it is partly about the potential decline in the use of cash, and what central banks should do about it.
How then would our monetary system fare with CBDCs? The CBDC debate is not about the technology, it is partly about the potential decline in the use of cash, and what central banks should do about it. However, in reality, for most countries, cash is still in high demand and so, in short, there is no urgency to find an alternative, though central banks need to be prepared for the future.
A cash substitute is in any case only one potential form of CBDC. Instead, the BIS has identified two main CBDC varieties. A wholesale model where the CBDC would be restricted to a limited group of users and used for interbank payments, and a retail model based either on digital tokens or on accounts and universally available. That translates to individuals being able to open an account directly with their central bank.Clearly, there are important differences between cash and CBDC. Unlike cash, CBDC is not anonymous. And a CBDC could pay or charge interest.
In terms of technology, the digital token technology is still broadly untested, whereas the technology for an account-based CBDC has been available for decades. So far, central banks have generally chosen not to provide such accounts because of concerns of the impact it would have on the financial system.
Our current system is built on two tiers. The customer-facing banking system is one tier, and the central bank is the other. The two tiers work together. The first tier is used for payments between accounts in the same bank, while payments to accounts in different banks are settled through the central bank system.
Currently, these settlement accounts are the only existing forms of CBDC, and only commercial banks have access to them. The challenge is that if central banks were to widen access to this CBDC then they would have to offer deposit accounts, issue debit cards and in effect offer many of the deposit services currently performed by commercial banks.
This could then increase, particularly in times of uncertainty when customers would inevitably prefer to have deposit accounts at central banks, and fewer at commercial banks. It follows on that if deposits shift to the central bank, then perhaps lending would need to shift as well. So, in addition to the deposit business, the central bank would be taking on the lending business, with all the commitments of time and resources that requires.
In this scenario, the role of the central bank starts to change dramatically. Traditionally, the central bank is a public institution charged with ensuring the economy runs smoothly and the financial system is sound. Commercial banks are private businesses that are driven by profit for their shareholders. Historical examples of one-tier systems where the central bank did everything, such as in countries of the Former Soviet Union, do not come recommended. Even publicly owned banks in many developing economies are hardly great examples of efficient allocation of funds or of good service.
It is true that token-based CBDCs may be less prone to this type of structural shift from the commercial banking sector, as the outstanding amount of the CBDC can be fixed. However, there would then be the question of whether these tokens would start to command a premium over bank deposits, especially during uncertain economic times.
We know from historical experience that, during times of financial stress, money moves away from risk to banks and assets that are regarded as safe. In such scenarios, it is not unrealistic to imagine that a premium would open up, where one euro of deposits in the commercial bank buys less than one euro’s worth of CBDC.
Finally, the introduction of CBDCs would change the environment in which central banks conduct monetary policy and thereby influence the economy. CBDCs would change the demand for base money and its composition in unforeseeable ways.
Furthermore, at least during a transitional period, all these changes have the potential to completely up-end the way that monetary policy affects the economy. Such changes are not ones that central banks take lightly.
Notwithstanding the above, central banks need to understand and evaluate digital currencies. The Committee on Payments and Markets Infrastructures (CPMI) at the BIS last year surveyed over 60 central banks, more than 70% of which said were working on CBDCs of some kind. However, only about half of these are actively testing the concept and only a couple are pursuing pilot projects.
Few central banks likely to issue CBDC
The same survey revealed very few central banks think it is likely that they will issue a CBDC in the short to medium term, be it retail or wholesale. It appears that having assessed the situation, most have decided to hold off.
Carstens concludes that this confirms his arguments that: (a) the introduction of CBDCs would have a major impact on the financial system; (b) there is not yet a widespread fall in the demand for banknotes; and (c) central Banks do not feel the need to accommodate a major change in the way they conduct monetary policy.
The debate on CBDCs is not about convenience and digitisation; rather, it’s about fundamental changes to two key components of the system that central banks oversee: money and payments. To date, experiments have not shown that the new technologies would be better than the existing ones, and the public are not convinced of the need of CBDCs; yet there are very significant operational consequences for central banks and implications for maintaining financial stability.
Central banks are conservative institutions and are proceeding with caution. Today’s central banks will continue to evaluate new innovations such as CBDCs, and adopt them when they are right for the economy and all sections of society.